The Federal Reserve suspended rate hikes at last week’s policy meeting, but Fed Chairman Jerome Powell told the House Financial Services Committee on Wednesday that more hikes were likely.
“Inflation has moderated somewhat since the middle of last year,” he said. said, but “inflationary pressures continue to be high, and the process of bringing inflation down to 2% still has a long way to go.” He added: “Almost all FOMC participants expect it to be appropriate to raise interest rates a little more by the end of the year.”
In the meantime, Fed Funds Futures continue to lean towards a single scenario, based on the highest probability estimates for the next three Fed meetings. After a 25 basis point increase at the July meeting, the crowd is assuming the target fed funds rate will peak at 5.25%-5.50%.
A simple model using unemployment and consumer prices to profile Fed policy suggests that a moderately tight profile prevails. It is a plausible though still unproven scenario to expect that rate hikes may soon end.
The 2-year US Treasury yield is also valued by anticipating that the target federal funds rate will reach or approach a peak. The policy-sensitive 2-year yield was unchanged yesterday at 4.68% (June 21). Although this key Treasury yield has risen 90 basis points over the past month, the fact that it remains below the fed funds rate reflects the market’s view that rate hikes are near a peak. .
The final arbiter of what happens next will almost certainly be the inflation numbers ahead. There are concerns that although inflation has peaked, the easing of price pressures has been slower and less persistent than the Fed would like. The good news is that the downward bias looks set to persist, based on the average change in the one-year pace of seven measures of inflation (for a list, see page 3 here).
CapitalSpectator.com’s ensemble prediction model for core CPI also points to weaker price pressure in the coming months, albeit at a slow pace, supporting the view that more than a rate hike is possible and possibly likely.
The litmus test, as always, is the actual data. The next key reality check is the June CPI report, due in a few weeks. For now, a cautiously optimistic outlook prevails that a “long way to go” may be a shorter way than hawks assume.
But if the doves take the leap, again the source of the disappointment appears to be a resilient economy, advises Tim Duy, chief US economist at GHS Macro Advisors. In a note sent to clients last week, after the Fed announced a pause, he explained:
The tightening cycle continues. We shouldn’t overlook the most recent SEP and its projection of another 50 basis points of rate hikes. The economy just didn’t crack as expected. As we have written, activity is more resilient than economists tend to predict. It is built with an internal bias for growth and currently has fiscal and demographic support. The longer this goes on, the more market participants, and the Fed, will suspect that the neutral rate has risen.
To resume and revise a famous line of the Clinton administration era, “It’s (still) the economy, silly.” In turn, the crucial question: will the economy remain resilient?
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